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A New Benchmark for Dividend Stocks

How to protect the purchasing power of your portfolio.

Identifying great dividend stocks is easier said than done. But while there are a variety of factors to consider -- from the size of the company to the regularity of its dividend payouts -- the one that stands out is the dividend yield -- the size of the dividend relative to the price per share.

With this in mind, I discuss a readily accessible benchmark you can use to identify quality dividend yields. I then go on to list five stocks that beat this mark and more.

Sizing up dividend yieldsTo determine whether or not a particular dividend yield was sufficiently generous, many investors used to compare it to the risk-free yield on the 10-year treasury bond. If it was above that mark, assuming everything else checked out, it was a worthy investment. And vice versa.

For a number of reasons related to the 2008 downturn, however, the yield on the 10-year has dropped so precipitously that it is now effectively meaningless. It presently stands at a mere 2%, less than half its pre-crisis level, and notably about 1.4 percentage points below the present rate of inflation. An investment at these rates would accordingly lose money in real terms.

So what should you use as a benchmark?My recommendation is that you use the rate of inflation, which was 3.4% as of November. This will do two things. First, it will get you into the habit of thinking in real as opposed to nominal terms. And second, it will help you to both protect and hopefully grow the purchasing power of your portfolio.

As you use inflation as a benchmark, moreover, you may also come to appreciate the power of dividends that regularly increase in size. Because inflation compounds over time, even a dividend yield that's higher than the rate of inflation won't protect your purchasing power unless you're disciplined about reinvesting it, and doing so profitably. One way to hedge against the compounding nature of inflation is to further limit your search to stocks with a consistent history of increasing dividend payouts.

To get you started in the right direction, the following table lists five dividend stocks with yields above the current rate of inflation and that have grown consistently over time. Let's take a look at them first, and then we'll discuss them further below.

Company

Dividend Yield

Years of Consecutive Annual Increases

10-Year Dividend Ann. Growth Rate

Old Republic International(NYSE: ORI)

7.6%

30

8.3%

AT&T(NYSE: T)

5.8%

28

5.3%

Altria Group(NYSE: MO)

5.5%

43

11.6%

Mercury General(NYSE: MCY)

5.4%

25

8.6%

Cincinnati Financial(Nasdaq: CINF)

5.3%

51

8%

Source: dripinvesting.org. As of Dec. 30.

So which of these five is the best for you?As I've discussed in a previous article, identifying the best dividend stock for your portfolio is a highly subjective exercise. There are, nevertheless, virtues to each.

The benefit of AT&T is that with mobile data usage on the rise and its virtual duopoly on the industry with Verizon, it offers both a generous yield and a certain level of comfort over the mid- to long-term.

Altria, on the other hand, has arguably the strongest competitive moat of the five, as it sells addictive products under one of the world's most recognizable brands, Marlboro.

Meanwhile, the well-run insurance firm Cincinnati Financial has consistently raised its dividend since the early 1960s. Not to mention, Fool Sean Williams opined not long ago that "insurers don't get much better than Cincinnati Financial" -- an opinion seconded by Fool John Rosevear.

The lesser-known title insurer Old Republic gained notoriety when it was announced in early December that the stock would be added to the S&P High-Yield Dividend Aristocrats list, which tracks the 60 highest-yielding stocks of the S&P 1500 that have increased their dividends every year for at least 25 years. An additional potential upside is that it's trading for just over $9 per share, which is well below its 52-week high of nearly $14.

And finally, dark horse candidate and automobile insurance provider Mercury General has a coveted four-star rating on CAPS and has been awarded a rating of "outperform" by 91.6% of CAPS All-Stars.

Foolish bottom lineSpeaking from personal experience, there are few things better in this world than depositing a nice, fat dividend check into your bank account four times a year. Unfortunately, it isn't always easy finding the right dividend stock for you. It's for this reason that one of our newest free reports discloses 11 monster dividend stocks for you to choose from. The recommendations include an underappreciated yet highly profitable energy company as well as a high-yielding telecom stock that's rewarding its shareholders handsomely. To access this limited-time report before it's no longer available, click here now -- it's free.

Foolish contributor John Maxfield does not have a financial stake in any of the companies mentioned above.The Motley Fool owns shares of Altria Group. Try any of our Foolish newsletter servicesfree for 30 days. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. The Motley Fool has adisclosure policy.